EUR 850.00 For Business Accounts Only

Morningstar | Goodman’s Focus on Quality Locations Underpins Rent Growth; FVE unchanged at AUD 10.20

The first-quarter fiscal 2019 operational update from Goodman Group contained no material new financial information, with guided growth in fiscal 2019 earnings and distributions reaffirmed at 7%. Our fair value estimate remains at AUD 10.20 and narrow-moat-rated Goodman screens as fairly valued at current levels.

Goodman management has been quite consistent with strategy over the past five years: buying, selling, and developing warehouses, with an objective of aligning the portfolio with what it deems to be the most desirable locations for its customers. In most respects the strategy follows the adage "location, location, location." In executing this strategy Goodman sold AUD 11 billion of assets in the five years to December 2017.

The second dimension of Goodman's strategy builds on its observation of its tenants, the larger of which have fitted out their warehouses with extremely expensive automation equipment. These customers realize they need to move with the times, and that to remain competitive in their markets they need to minimize their logistics costs and have the capacity to deliver goods quickly to their customers. Goodman appears to be focusing its new developments to cater to the growing technology requirement of its tenants. The facilities it is developing increasingly have floorplates that are laser flat, a common requirement for mobile fulfillment robots, similar to the Kiva robots used by Amazon.com. Other design nuances include high-quality electricity to minimize risk to automation equipment, high ceilings to achieve greater site leverage, and cross-docking facilities to facilitate rapid stock transfers between incoming and outgoing truckloads.

We find the most challenging aspect of assessing logistics owners like Goodman is quantifying the very long-term demand requirements for facilities. There are simply too many unknowns for anyone to forecast a long-term logistics demand profile of each country and individual city with any degree of reliability. For each and every city there is a unique set of demand variables, the most significant being population growth rates, geographic migration patterns and rates, economic growth, global shifts in manufacturing, growth rates in e-commerce, design changes in logistics, robotics takeup rates, rate of new supply additions and town planning policies. The most important driver at present is growth in e-commerce, as it appears to be the major catalyst for businesses to upgrade their facilities. Businesses are upgrading so they can get their products to customers faster to stay ahead of competitors. In isolation, the e-commerce bandwagon points to a long wave of demand ahead.

The major downside risk we see is automation, as it enables operators to make far better use of their facilities. Previously, nearly all activity in warehouses occurred within the bottom 2-3 meters of a 10-meter-high warehouse. Whereas now, in highly automated warehouses, the buildings are often 14-16 meters high and nearly all of this vertical height is leveraged, rather than the lower few meters. Despite the risk of automation, there appears to be very few facilities that align with contemporary logistics requirements, which is why we forecast Goodman’s development led business stands to have a long demand profile ahead. We account for the risk of automation and period of economic contraction in Goodman’s key markets in our long-term forecast, by assuming the growth rate in the firm’s development completions increases at modest compound annual growth rate, or CAGR, of 2% over the next decade. This is still substantial growth, resulting in Goodman delivering AUD 3.6 billion in new warehouses in fiscal 2019 and this growing to AUD 4.5 billion in 2028. If we assume a CAGR of 3% over this period, this boosts our fair value estimate by 4.5% to AUD 10.65. If we assume a 4% CAGR boosts our fair value estimate by 10% to AUD 11.20.

An evolving trend in logistics that appears to have started in densely population Asia is multilevel logistics. Facilities can have as few as two floors, but there are examples in infill location that are as high as 20 floors and look more like an office tower than a warehouse. More recent examples often contain substantial associated office space, which attracts premium rents. Skyrocketing land prices and the desire of town planners to limit the amount of land used for logistics are the catalysts for these new facilities. To date, few of these facilities have been built, but those that have are extremely valuable as they tend to only get built in close proximity to major transport infrastructure and there is competition among tenants to operate from these facilities, which drives up rents. Goodman has already developed a few of these facilities in Japan, China, and Hong Kong. Going forward, the development of multilevel warehouses is a growth focus of Goodman. We see the advent of multilevel warehouses as a positive for logistics valuations as the large floor areas of these facilities means less are likely to be built, resulting in more scarcity in logistics facilities.